Phisix: How Sustainable is the Bernanke Put?

“Highly accommodative monetary policy for the foreseeable future is what's needed…If financial conditions were to tighten to the extent that they jeopardized the achievement of our inflation and employment objectives, then we would have to push back against that…

The above statements[1] made by US Federal Reserve Chairman Dr. Ben Bernanke this week had been enough to power or push the previously uncommitted global financial markets into a risk ON environment and to the setting of records for US stock markets[2]. 

If this is so, then why does the mainstream adamantly insist that prices in the financial markets are supposedly set by the conventional notion of fundamentals such as “valuations” or statistical “economics” rather than by monetary policies?

The implication is that the monetary landscape determines the conventional notion of “fundamentals” and that the corollary—drastic changes in the monetary environment—will radically alter “fundamentals”.

Thus a financial and economic environment nurtured by easy money will have almost been entirely dependent on the continuity of such dynamic; such that, to reiterate, a reversal of which translates to a massive dislocation or a withdrawal “shock” from which the current financial and economic environment has been implanted on.

Of course the basic question is how sustainable are these free lunch monetary policies?

As previously pointed out, the recent riots in the global bond markets seem as signs of the unintended consequences or a growing backlash from these policies[3].

Yields of US long term bonds have gradually been ascendant since July 2012. The Fed’s QEternity last September (which had only a 3 months effect), Kuroda’s Abenomics in April and the ECB’s interest rate cut have all failed to stem rising yields.

Yet the rate of increases only intensified when the financial markets selectively ‘focused’ on the ‘tapering’ aspect of the rather ambivalent Fed’s communiqué last May[4].

The US bond market rout quickly cascaded into a pandemonium in the stock and bond markets particularly in the emerging markets, as well as parts, of the US fixed income markets.

And given the estimated $225 trillion capital markets where 78% comprises the interest rate sensitive bond and loans markets, combined with the $490 trillion interest rate swap derivatives markets, a sustained spike in bond yields will only aggravate the bedlam in the global financial markets[5].

Thus, the Fed’s signaling channel or communications strategy or inflation expectations management fiasco has immediately been remedied by promises to contain interest rates by the announcement of “forward guidance” by Mark Carney of the Bank of England, the jettisoning of the non-committal stance by the European Central Bank where Mario Draghi declared low levels for an “extended period of time” and finally Dr. Bernanke’s “highly accommodative monetary policy for the foreseeable future”. 

This time the steroid starved markets focused on Dr. Bernanke’s missives while ignoring the fact that in the minutes of the FOMC meeting about half of the participants wanted to halt the $85 billion in monthly bond purchases by year end[6].

The predicament is that what seems as diminishing marginal efficiency or returns and of the narrowing window of impact of such policies, it remains to be seen if jawboning alone will be enough to sustain the risk ON environment based on the Bernanke Put.

Greater Risks from China’s Selective Interventions

The hunger for policy steroids has infected China too.

Rumors floated that China’s government may soften her stance on monetary policy, which prompted for a one day 3.23% surge on the Shanghai Composite index.

The following day China’s economic data showed of mixed outlook in terms of monetary affairs.

Money supply growth showed of a marginal decline. M2 rose by only 14% in June from May’s 15.8% growth. Meanwhile, new currency loans soared by 860.5 billion yuan in June vastly up from 667.4 billion yuan in May. This according to the Bloomberg[7], accounted for about 83 percent of aggregate financing last month. 

Yet a big part of this credit expansion has been coursed through China’s four biggest state owned banks which stood at an “unusually large 170-billion yuan ($27.7bn) in the first week of July”[8].

Friday, the Shanghai composite index gave up about half of the Thursday’s gains, but still posted a positive 1.61% return for the week.

The Chinese government’s declared measures of stamping out the shadow banking system but at the same time expanding loans via state owned banks extended to mostly State Owned Enterprises and politically connected firms will most likely backfire as political distribution of money will only compound on the existing distortions[9] on the marketplace by increasing the yield chasing phenomenon that increases systemic risks via further inflation of the debt driven property bubble.

One clue of this is that given China’s underdeveloped capital markets or with the limited options for the average Chinese to invest, falling stock markets has prompted for a record flows into the shadow banking system’s wealth management products[10] during the last two weeks of June.

And my guess is that some, if not a big portion of these funds, will also flow into the shadow banking system.

The Chinese government can control the stock of money issuance, but they will not be able to control the flows of money.

The Chinese government’s selective targeting of monetary interventions has already been affecting her merchandise trade activities as exports and imports jointly fell last June[11]. 

In addition, the cash crunch has prompted many car dealers to have reportedly withheld shipments without upfront payments[12]. The cash squeeze has also caused a drought on sales of dollar-denominated junk bond or Chinese speculative-grade companies[13].

Meanwhile consumer price inflation rose 2.7% beyond median estimates at 2.5%, even as producer prices fell by 2.7%[14], which shows of the stagflation setting the Chinese economy has transitioned into.

The distribution of credit by political means where the incumbent Chinese government expands credit via state owned banks will likely be policy trend going forward. Such interventions are likely to heighten risks of a disorderly adjustment in China’s highly fragile debt laden economy.

As Columbia University finance and economics Professor Charles Calomiris wrote in a 2009 paper on banking crises[15]

This pandemic of bank failures has been traced empirically to the expanded role of the government safety net, as well as government involvement in directed credit. Government protection of banks and government direction of credit flows has encouraged excessive risk taking by banks and created greater tolerance for incompetent risk management(as distinct from purposeful increasesing risk). The government safety net, which was designed to forestall the (overestimated) risks of contagion, ironically has become the primary source of systemic instability in banking.

The more the interventions, the more the risks of a policy error.

ASEAN Stocks: Sharp volatilities hardly mean stabilization

Another huge beneficiary from Dr. Bernanke’s “highly accommodative monetary policy for the foreseeable future” has been ASEAN bourses.

Thursday, Bernanke’s announcement prompted Thailand’s SET to fly 4.22% (upper window) while Indonesia’s Jakarta Composite Index jumped by 2.8% (lower window). Both bourses[16] were up this week by .86% and .66% respectively. The marginal weekly gains reveal of the sharp volatilities experienced by both equity markets which means earlier steep losses were recouped from Dr. Bernanke’s blandishments.

I noted in the past that one consolation from the recent bear market foray by the Phisix has been that none of our neighbors has touched the bear market.

I wrote back then[17],

A consoling factor has been that the stock markets of Thailand and Indonesia has not fallen into the bear market zone…at least not yet. If these three major ASEAN markets will synchronically submit into the domain of the bears, then the bigger the risks of a full bear market cycle.

But charts of the SET and the JCI has not been comforting, while the SET has managed to slightly break above the downtrend, it is unclear if this can be sustained.

On the other hand, the JCI can be interpreted two ways depending on one’s bias, a descending triangle (bearish) and a potential double bottom (bullish).

The point being, the sustainability of momentum molded from the Fed’s policy guidance seems uncertain. This will most likely be determined by actions of the global bond markets.

And amidst the bond market turmoil, the Indonesian government managed to raise US $1 billion of dollar bonds last week which media cheered since this has been “twice oversubscribed”. But this comes with a catch; they were oversubscribed because of significantly higher rates.

From the Jakarta Post[18] (bold mine)

Investors were attracted by the 10-year dollar securities’ high yields, which reached 5.4 percent — the highest in three years. The yield, which is 282 basis points below the premium US treasuries, was also significantly higher than the government’s last global bonds auction on April, which offered the 10-year dollar notes at 3.5 percent.

So yes, one can still raise money but at significantly higher yields.

Developments in the bond markets continue to cast a pall over the stock markets.

Sharp volatilities hardly mean stabilization.

The Phisix posted a modest 1.13% gain over the week. But this comes after three days of sluggishness which resulted to a little over 3% loss. Bernanke’s guarantees incited a remarkable two day 4.17% snapback which reversed the weekly losses. Overall the Phisix endured a pendulum swing by about 7%. Simply amazing.

Yields of 10-year Philippine bonds also significantly retrenched while the Peso was unchanged for this week which are positive signs.

Again given the immense volatilities in the financial markets here and abroad, external developments are likely to influence market movements more than by internal dynamics.

In short, the Phisix will likely move in the direction along with her regional peers as influenced by the direction of global bond markets.

Excessive volatility also translates to a risky environment.

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[1] Reuters.com Bernanke: Highly accommodative policy needed for 'foreseeable future July 10, 2013

[2] See US Stocks Hit Record Highs as the US Dollar Dives July 12, 2013

[3] See How Volatile Bond Markets May Affect the Phisix, June 3, 2013

[4] See Phisix in the Shadows of a Bursting Global Bond Market Bubble June 24, 2013

[5] See How Rising US Treasury Yields May Impact the Phisix July 8, 2013

[6] See China, ASEAN Stocks Fly on Hopes for Steroids July 11, 2013

[7] Bloomberg.com China Squeezes Shadow Banking as Li Grapples With Growth, July 13, 2013

[8] Business Day Live South Africa Global equities rise on US Fed comments July 11, 2013

[9] See Confessions of a Shadow Banker in China: It's the Formal Sector that it at Risk, July 10, 2013

[10] Bloomberg.com Shadow Bank Assault Backfires as Rates Lure Cash: China Credit July 4, 2013

[11] Bloomberg.com China Exports Unexpectedly Drop; Imports in Economy Drag, July 10, 2013

[12] Bloomberg.com Chinese Cash Squeeze Causes Auto Dealer Panic, Group Says July 10, 2013

[13] Bloomberg.com Junk Sales Halt as Morgan Stanley Recommends Hedge: China Credit July 10, 2013

[14] Bloomberg.com China Faltering Demand Proved as Producer Prices Slump July 9, 2013

[15] Charles W. Calomiris BANKING CRISES AND THE RULES OF THE GAME NBER Working Papers October 2009

[16] Bloomberg.com Asia-Pacific Stock Indexes

[17] See Phisix: Don’t Ignore the Bear Market Warnings June 30, 2013

[18] Jakarta Post Dollar bonds sold out, but with high yields July 12, 2013

How Stock Markets React to Rising Oil Prices

I have been repeatedly stating that rising stock markets in conjunction with expanding leverage amidst rising interest rates (as expressed via bond yields) constitutes a ‘Wile E. Coyote moment’ for me. 

This doesn’t explicitly mean that equity markets won’t rise, but this means that the further and steeper the increase of the stock markets, in the face of a continuing massive buildup of imbalances, the greater the risks of a bear market or a stock market crash.

In short, debt based asset inflation is simply incompatible with rising yields.

Eventually when interest rates reach certain levels where a critical mass of investments or punts pillared by debts or loans would be rendered unprofitable, and where debt becomes unserviceable, a feedback loop mechanism of margin calls on loans will impel for liquidations which consequently forces down prices of securities and vice versa.

Thus inflationary boom transitions into deflationary bust

Producer Prices as Signs of Inflationary boom

At the start of the year I wrote this[1]

Yet interest rates will ultimately be determined by market forces influenced from one or a combination of the following factors: balance of demand and supply of credit, inflation expectations, perception of credit quality and of the scarcity or availability of capital.

I have pointed out last week that rising treasury yields partly reflected on the increasing take up on bank credit. This has been confirmed as bank loans in the US nears record levels

From Business Times Singapore[2]

Bank lending to US companies is rising at a pace that will by year-end push the total above the record high of US$1.61 trillion reached in 2008.

Commercial and industrial loans outstanding climbed to US$1.56 trillion in the week ended June 26, an increase of 4.1 per cent this year and up from the low of US$1.2 trillion in October 2010 following the worst financial crisis since the Great Depression, according to Federal Reserve data. The amount surged about US$18 billion last month, the most this year.

And on the back of this inflationary boom has been the expected rise of input prices as partially represented by US producers prices. 

U.S. producer prices, according to the Wall Street Journal Blog[3], increased for the second straight month in June and are up 2.5% from a year earlier, the largest 12-month increase since March 2012

Lubricated by expansionary credit, industries in the private sector experiencing credit induced booms along with the government spending will extrapolate to increased competition for specific resources required for their projects. Thus greater demand for resources would be reflected on as price pressures on relative input factors particularly of wages, rents, and producer prices on the capital good sector.

As the great dean of Austrian economics Murray N. Rothbard explained[4]: (bold mine)

Now what happens when banks print new money (whether as bank notes or bank deposits) and lend it to business? The new money pours forth on the loan market and lowers the loan rate of interest. It looks as if the supply of saved funds for investment has increased, for the effect is the same: the supply of funds for investment apparently increases, and the interest rate is lowered. Businessmen, in short, are misled by the bank inflation into believing that the supply of saved funds is greater than it really is. Now, when saved funds increase, businessmen invest in "longer processes of production," i.e., the capital structure is lengthened, especially in the "higher orders" most remote from the consumer. Businessmen take their newly acquired funds and bid up the prices of capital and other producers' goods, and this stimulates a shift of investment from the "lower" (near the consumer) to the "higher" orders of production (furthest from the consumer)—from consumer goods to capital goods industries

In other words, price inflation will unevenly be felt by different sectors but this will be most evident in the capital goods industries.

However, competition for credit and resources would not necessarily translate to consumer price inflation. Nonetheless, competition for credit and resources could also exert upside pressure on interest rates that would eventually put marginal projects on financial strains, including margin debts on financial assets operating on leverage, which lay seeds to the upcoming bust. 

The seeming absence of generalized price inflation will mask the boom-bust structure and mislead the mainstream into assuming the sustainability of such dynamic.

How Stock Markets React to Rising Oil Prices

Last week’s bonanza from Mr. Bernanke’s Put option on the markets succeeded to recreate a 2009-2011 boom scenario where stocks, commodities and bonds rallied.

I mentioned commodities. 

Oil Prices in the US, as measured by the West Texas Intermediate crude[5] (WTIC), has sharply risen during the past month. The WTIC has even narrowed the gap of European based oil benchmark the Brent crude[6] (BRENT). The other major benchmark the OPEC Reference basket[7] also posted substantial increases. Meanwhile the Dubai Crude[8] has shown marginal increases.

Gasoline (GASO) prices in the US have also surged during the last month.

If the increase in oil prices will be sustained, then this will add to producer price inflation and could even possibly get reflected on consumer price inflation. And an increase in price inflation expectations will likely add an inflation premium on the interest rate markets. This should put increased pressures on the mercurial bond markets.

Aside from rising interest rates, a trend of higher oil prices has not been compatible with climbing stock markets.

For the three occasions where oil prices as measured in WTIC (blue) topped $100, the upside momentum of the S&P 500 (red) had been truncated.

In 2008, as the WTIC soared to $147 per bbl, the S&P crashed as the US housing and mortgage deepened. Eventually the deflationary bubble bust spread to oil prices which also collapsed.

University of California economic professor James Hamilton argues that an “oil shock” played a substantial role in the recession of 2008[9]. Mr. Hamilton further noted that high oil prices had been linked with 11 of the 12 post World War II recessions[10].

Twice when oil prices popped beyond $100 in 2011 and 2012, the S&P’s rise turned into a correction.

If history should rhyme, then one of the two discordant factors will unravel. Which will it be oil or stock markets? Or could there be a third option where both implode? 

An Oil Price Bubble?

What has driven prices of oil to recent highs?

Certainly not demand from China as crude oil imports fell in the first half of 2013. Such decline, according to the Wall Street Journal[11], marks the first January-June contraction since the depths of the financial crisis in 2009. If China’s economy continues to flounder then oil imports are likely to fall further unless the Chinese government will use this opportunity to increase their stockpile of strategic petroleum reserves[12].

US demand will reportedly grow marginally in 2013 based on Energy Information Administration (EIA) estimates. According to the Wall Street Journal[13], “Demand in the world's biggest oil consumer will average 18.66 million barrels a day this year, up 0.6% from a year earlier. Last month, the EIA forecasted growth of 0.5%.”

The popular wisdom is that recent US oil price increases signifies a seasonal factor—the summer driving season.

Global oil demand is projected as lacklustre for 2013 and 2014. OPEC estimates that global oil demand, according to the IBTimes[14], will slow by 400,000 barrels per day in 2013 and will rise by 300,000 barrels per day in 2014.

Meanwhile, the International Energy Agency (IEA) expects also marginal growth for global oil consumption. According to the Platts.com[15], the IEA said global oil demand is forecast to grow by 1.3% to reach 92 million barrels a day in 2014, underpinned by a stronger global economy. That’s 1.3% growth for a strong economy, but how about a weak economy enervated by tight money?

The IEA expects global oil production to outpace consumption led by “surging supplies of oil from the US and other non-OPEC producers”

US oil output driven by shale gas and oil has reached records where US oil production now meets 89% of its energy needs according to the Energy Information Administration (EIA).

According to the Bloomberg[16], “Domestic crude output will average 7.31 million barrels a day in 2013 and 8.09 million in 2014, the EIA, a unit of the Energy Department, said in the report.

Could spiking oil prices have been about geopolitics perhaps Egypt or Syria? Possibly but unlikely…yet.

Although the threat of an oil supply shock could occur if events in Syria deteriorates

As Martin Katusa of Casey Research explains[17]

The roots of the differences go back to the 7^thcentury CE, with the death of the prophet Muhammad. Those who accepted Abu Bakr, Muhammad's father-in-law, as caliph (meaning successor) became known as the Sunnis. Those who believed that Ali, Muhammad’s son-in-law, should be caliph became the Shiites. From there, the differences grew, many battles ensued, and a schism formed between the two groups.

Why has the American government backed the Sunnis, you may ask. Saudi Arabia is the short answer.

If a decisive Shiite victory were to occur in Syria, it would have enduring implications throughout the Middle East, but most importantly in Saudi Arabia. Though Saudi Arabia's population and leadership are both Sunni, and two of the holiest cities of Islam (Mecca and Medina) are situated in the country, the oil-producing areas in the eastern portion of the country have significant Shi'a populations. If an uprising were to occur there in response to Shiite success in Syria, Saudi Arabia's oil production (as well as economic, political, and social stability) would suffer a huge setback.

It is critical for both the US as well as the European Union that Saudi Arabia stay as it is to keep the balance of power intact in the Middle East. That's seen as a necessity for stability in the global oil markets. If Saudi Arabia's oil production were to stop, we could be looking at US$200 or more per barrel of oil immediately. That's how important Saudi Arabia is to the spot oil price.

Egypt’s plight seems hardly different, but may be of lesser impact. A push towards a more anti-US Islam fundamentalist regime from the current secular government is likely to impact geopolitics of oil in the same context as Syria. 

Egypt’s oil production[18] has seen a substantial but decline overtim while oil exports[19] have partly reflected on production activities and could be reasons why events in Egypt may not impact oil markets dramatically.

So if oil prices has not been about tight supplies, hardly been about real demand or unlikely about geopolitics then why the price spiral?

Well the likely answer is oil speculation or an oil bubble.

The research team from Credit Suisse suggests that this has been about the unwinding of carry trades[20]:

For the last two to three years, just as the Federal Reserve drove investors to look ever harder for yield, WTI’s steep contango provided a neat carry trade, allowing it to be a fairly steady provider of decent (if unspectacular) returns.

Boiled down to the basics, investors were selling one year out time spreads, where the curve was relatively flat, and waiting for them to move into contango as the futures approached the prompt month. Now that the WTI curve has flipped into backwardation, this trade no longer works and the remaining, perhaps significant, positions are being unwound.

To do so, funds must buy the front and sell the back, further exacerbating WTI’s backwardation.

Whether this has been about the unwinding of the contango based carry trades or not, rising oil prices in the backdrop of easy money environment and monetary pumping by the central banks means that bubble activities, marked by yield chasing dynamics, has apparently percolated into the oil markets.

And tight money is likely to prick the oil bubble as in 2008 unless oil will be seen as an inflation hedge like gold.

Rising Oil Prices Will Impact Real Economies

The heavy dependence on energy imports by Japan, especially amidst the closure of nuclear power plants which previously accounted for 30% of energy generation, and which has been replaced by Liquefied Natural Gas (LNG) and Petroleum according to the EIA[21] makes Japan highly vulnerable to a spike in oil prices.

The good news is that rising international prices of oil will help Kuroda’s Abenomics, via doubling of the money supply in two years, hit their target of attaining price inflation as a weaker yen will amplify price hikes in foreign currency or in US dollar terms. 

The bad news is that a surge in price inflation will likely put additional pressure on the highly fragile Japanese bond markets or JGBs which increases the likelihood or risks of a debt crisis.

Finally it isn’t true that high oil prices will curb demand as popularly explained by media. Instead high oil prices represent an income transfer from oil consumers to oil producers. High oil prices will benefit producers that will encourage additional oil production aside from incentivizing consumption on other aspects.

Whereas consumption patterns of oil consumers will likely shift towards more energy conservation or may lead oil consumers with lesser disposable income.

Vietnam, India, China and Thailand with oil and other energy use accounting for 20% or more in % of GDP, appears as most vulnerable to sustained increases in oil prices according to the 2010 estimates by PIMCO[22].

One can omit the Japanese data, since this was computed prior to the Tohoku earthquake where nuclear power played a big role in Japan’s energy generation.

The Philippines is shown as one of the least vulnerable which for me is quite surprising. Since I doubt that the Philippines has reached energy efficiency levels similar to her relatively more developed neighbors, I suspect that there has been significant errors in measuring real energy usage (perhaps due to non-inclusion of the informal economy) or from some other factors which is beyond my thoughts as of this writing.

Nonetheless high oil prices amidst revolting bond markets increases the market risks.

Trade with caution

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[1] See What to Expect in 2013 January 7, 2013

[2] Business Times Singapore US business loans set to break '08 record July 11, 2013

[3] Wall Street Journal Economics Blog Wholesale Price Jump Unlikely to Impact Consumers July 12, 2013

[4] Murray N. Rothbard, The Positive Theory of the Cycle Business Cycle Theory America’s Great Depression Mises.org

[5] Wikipedia.org West Texas Intermediate

[6] Wikipedia.org Brent Crude

[7] OPEC OPEC Basket Price

[8] Mongabay.com Crude Oil, Dubai - free price chart

[9] James D. Hamilton Oil prices and the economic recession of 2007-08 June 16, 2009 voxeu.org

[10] Reason.com Oil Price Shocks and the Recession of 2011? March 8, 2011

[11] Wall Street Journal China' Crude-Oil Imports Fell in the First Half July 10, 2013

[12] Wikipedia.org Strategic Petroleum Reserves (China)

[13] Wall Street Journal EIA Inches U.S. 2013, 2014 Oil Use Up From June Outlook July 9, 2013

[14] International Business Times OPEC Sees Demand For Its Own Crude Slipping, As Global Oil Demand Rebounds July 10, 2013

[15] Platts.com IEA sees oil demand growth outpaced by non-OPEC supply in 2014 July 11, 2013

[16] Bloomberg.com Fracking Pushes U.S. Oil Output to Highest Since 1992 July 11, 2013

[17] Marin Katusa If Syria Falls, Expect a Pop in Oil Prices Casey Research July 2, 2013

[18] IndexMundi.com Egypt Crude Oil Production by Year

[19] IndexMundi.com Egypt Oil - exports

[20] Isabella Kaminska The WTI carry unwind FT Alphaville July 10, 2013

[21] EIA.gov Japan’s fossil-fueled generation remains high because of continuing nuclear plant outages March 15, 2013

[22] PIMCO.com Tomoya Masanao and Robert Mead Discuss PIMCO’s Asia-Pacific Cyclical Outlook April 2011

Quote of the Day: This Time is Different--Cyprus Edition

Cypriots are deeply shocked by these events. From "insiders" who sat on boards to politicians and ordinary citizens, no one can believe that the EU treated them the way they did. I was asked time and again, "How could this happen?" and not just by ordinary citizens.

I talked with one lady who had just retired from the Bank of Cyprus. She had 100% of her pension and life savings at the bank and now faces losses of up to 60%. She had no idea the crisis was coming. Interestingly, she and others I spoke to insisted that the Bank of Cyprus was a good bank. But when asked if she would redeposit her money in a Cypriot bank when (if) she ever gets it out, she shook her head no. The trust in the system is gone.

I talked with Symeon Matsis, a man in his early 70s who was at one time in charge of planning at the Ministry of Finance. He carried a copy of This Time Is Different by Rogoff and Reinhart. It was dog-eared and full of notes. "I am reading it so I can try to understand what happened to us. The more I read the more I understand that they were describing Cyprus. And we did think that 'This country is different.' Which is why the crisis has been such a shock to our local culture."

The Cypriots believed not just that their country was different but also that the stability they had seen for 40 years was normal and easy to achieve. Why would it end? They were just doing their jobs, and everything seemed OK … until it wasn't.

This is from John Mauldin from his latest piece: The Bang! Moment Shock. 

The Cyprus credit event serves as an important paradigm of the abruptness of the unraveling of bubble cycles. "This time is different" is something so entrenched among the mainstream, who continues don rose-colored glasses amidst mounting systemic imbalances, such that when the tail event arrives, as John Mauldin aptly describes, The bang becomes a moment shock.

Edward Snowden statement: "It was the right thing to do and I have no regrets"

In Moscow, whisteblower Edward Snowden lashes back at the US government.

From the Guardian (hat tip lewrockwell.com)

Full transcript of the statement made by Edward Snowden, in which he accepts all offers of asylum he has been given

Statement by Edward Snowden to human rights groups at Moscow's Sheremetyevo airport, posted by WikiLeaks:

Friday July 12, 15:00 UTC

Hello. My name is Ed Snowden. A little over one month ago, I had family, a home in paradise, and I lived in great comfort. I also had the capability without any warrant to search for, seize, and read your communications. Anyone's communications at any time. That is the power to change people's fates.

It is also a serious violation of the law. The 4th and 5th Amendments to the Constitution of my country, Article 12 of the Universal Declaration of Human Rights, and numerous statutes and treaties forbid such systems of massive, pervasive surveillance. While the US Constitution marks these programs as illegal, my government argues that secret court rulings, which the world is not permitted to see, somehow legitimize an illegal affair. These rulings simply corrupt the most basic notion of justice – that it must be seen to be done. The immoral cannot be made moral through the use of secret law.

I believe in the principle declared at Nuremberg in 1945: "Individuals have international duties which transcend the national obligations of obedience. Therefore individual citizens have the duty to violate domestic laws to prevent crimes against peace and humanity from occurring."

Accordingly, I did what I believed right and began a campaign to correct this wrongdoing. I did not seek to enrich myself. I did not seek to sell US secrets. I did not partner with any foreign government to guarantee my safety. Instead, I took what I knew to the public, so what affects all of us can be discussed by all of us in the light of day, and I asked the world for justice.

That moral decision to tell the public about spying that affects all of us has been costly, but it was the right thing to do and I have no regrets.

Since that time, the government and intelligence services of the United States of America have attempted to make an example of me, a warning to all others who might speak out as I have. I have been made stateless and hounded for my act of political expression. The United States Government has placed me on no-fly lists. It demanded Hong Kong return me outside of the framework of its laws, in direct violation of the principle of non-refoulement – the Law of Nations. It has threatened with sanctions countries who would stand up for my human rights and the UN asylum system. It has even taken the unprecedented step of ordering military allies to ground a Latin American president's plane in search for a political refugee. These dangerous escalations represent a threat not just to the dignity of Latin America, but to the basic rights shared by every person, every nation, to live free from persecution, and to seek and enjoy asylum.

Yet even in the face of this historically disproportionate aggression, countries around the world have offered support and asylum. These nations, including Russia, Venezuela, Bolivia, Nicaragua, and Ecuador have my gratitude and respect for being the first to stand against human rights violations carried out by the powerful rather than the powerless. By refusing to compromise their principles in the face of intimidation, they have earned the respect of the world. It is my intention to travel to each of these countries to extend my personal thanks to their people and leaders.

I announce today my formal acceptance of all offers of support or asylum I have been extended and all others that may be offered in the future. With, for example, the grant of asylum provided by Venezuela's President Maduro, my asylee status is now formal, and no state has a basis by which to limit or interfere with my right to enjoy that asylum. As we have seen, however, some governments in Western European and North American states have demonstrated a willingness to act outside the law, and this behavior persists today. This unlawful threat makes it impossible for me to travel to Latin America and enjoy the asylum granted there in accordance with our shared rights.

This willingness by powerful states to act extra-legally represents a threat to all of us, and must not be allowed to succeed. Accordingly, I ask for your assistance in requesting guarantees of safe passage from the relevant nations in securing my travel to Latin America, as well as requesting asylum in Russia until such time as these states accede to law and my legal travel is permitted. I will be submitting my request to Russia today, and hope it will be accepted favorably.

If you have any questions, I will answer what I can.

Thank you.

Fitch downgrades France: how credit rating changes impacts the markets

France will celebrate Bastille day with a bad news, Fitch Ratings joined S&P and Moody’s in stripping France of its AAA credit rating.

From Bangkok Post:

Ratings agency Fitch downgraded France from the top AAA credit rating on Friday, citing a heavier government debt load and poor prospects for growth.

In slashing France's rating to 'AA +', Fitch became the last of the big three credit raters to knock France off the top perch. Last year Standard & Poor's and Moody's already downgraded France from the AAA club.

Fitch, which is part French owned, had warned in its previous appraisal that France had reached the very limit of being able to hold on to its top grade grail.

But with Fitch now expecting public debt to peak next year at 96 percent of gross domestic product, the agency said it had no choice but to lower the mark, though with a stable outlook.

I think that France deserves more, or that the present downgrades may just be the start of the string of downgrades that France will be faced with.

But the actions of the credit rating agencies gives some very important insights, particularly on the effects of re-ratings on the marketplace.

Contra to the mainstream intuition that downside re-ratings of debt should translate to higher interest rates as default risk premium should rise, the S&P and Moody’s actions in 2012, particularly in January and November, respectively, came in backdrop of the opposite direction:a colossal rally 10 year bonds expressed via sharply lower yields. 

So the French government can easily issue a rejoinder to these credit rating agencies saying “you fools, the market says you are wrong!”

But of course, this has not been simple. 

Part of that rally has been due to the series of credit easing policies by the ECB since the financial crisis of 2007, and, more importantly, the  ECB’s implicit backstop. ECB’s Mario Draghi unveiled the details of the bond buying scheme via outright monetary transactions, or OMTs last September.

The US Federal Reserve has also reportedly injected over $1 trillion in cash to European banks with US operations. Such funds may have also been used to buy government European debt too.

Other factors as such as changes in reserve requirement could have also contributed to bond boom. Fund manager Charles Gave of Gavekal Research recently wrote: (bold original)

Knowing this, why then are French rates so low? The usual explanations (purchases by the Swiss National Bank and Mrs. Watanabe buying) have some merit, but other factors may also be at play. France has a large financial sector, with huge international positions. Some entities may be selling international holdings which demand large reserve requirements. The proceeds are then brought back in France to buy French government bonds—against which there are no reserve requirements.

The economic impact of such a trend would indeed be benign for interest rates. But ultimately, it raises the risk on the French financial balance sheet: less diversity, and more vulnerability to a problem with the local sovereign.

In short, there has been a lot of moving parts, mostly political interventions, that has led to the bond rally.

The popular wisdom is that upgrades and downgrades impact the equity markets where upgrades lifts the markets while downgrades should do the opposite.

Well in the French case, this simply has not been true.

And as I previously pointed out, French markets and the economy has gone in antipodal directions and thus a parallel universe. Sporadic recessions through 2012 hasn’t stopped the French equity benchmark the CAC 40 from booming.

France has seen booming bond markets and stock markets amidst intermittent recession and credit rating downgrades—all contradictory to mainstream wisdom.

Of course, all these have operated on the backdrop of an easy money landscape which is about to change.  The developing “head and shoulders” formation in the CAC 40 could serve as clue.

The lesson here is that the credit rating upgrades or downgrades have little relationship with market actions. And for those in the mainstream who tout these to justify a bias, they are most likely to be misguided and wrong.

Quote of the Day: Quackroeconomics

In discussions of macroeconomic policy in Washington and in the press, these four propositions are taken as given:

(S) Spending is what drives the economy. Spending creates jobs, and jobs create spending. When unemployment is high, the problem is too little spending.

(M) Monetary policy must steer the economy carefully between overheating and slumping. Doing so requires high levels of skill and intellectual resources.

(F) Fiscal policy is just as important. When there is unemployment, monetary policy cannot do the job alone, because the Federal Reserve also has to keep an eye on inflation. So the Federal government must engage in deficit spending to stimulate the economy.

(C) Computer models are essential tools that enable economists to forecast the economy and assess the impact of alternative economic policies. Using computer models, the Congressional Budget Office is able to score the number of jobs a particular policy will add to or subtract from the economy.

These four propositions are what I term quack macroeconomics, or quackroeconomics for short. Like quack medicine, quackroeconomics is unproven, unreliable, inconsistent with the views of leading researchers in the field, and possibly dangerous.

This is from economic blogger and author Arnold Kling at his blog. 

I would add to quackroeconomics the mistake of rigidly interpreting statistical (historical-empirical) data as economic analysis.

War on Cash: Paying Cash Leads To Police Raid

Paying in cash can lead to a police raid. Austrian Economist Joseph Salerno at the Mises Blog narrates:

It all started one Saturday morning when Jarl Syvertsen, a 59-year-old disabled Norwegian man, purchased a PC, TVs, and washing machines for 80,000 kroner (roughly US$13,000) which he paid in cash. The store immediately alerted the police about the large cash payment. On Sunday a male and a female police officer appeared on Mr Syvertsen’s doorstep. Upon seeing them, Mr. Syvertsen at first feared that something may have happened to his mother, who is 86 years old and resides in a nursing home. But the police were there with a warrant to search his home, charging that the cash he had spent was money that “came from a criminal offense.” In fact, the money was actually part of an approximately one-million dollar advance on an inheritance he had received. Mr. Syvertsen attempted several times to explain to the officers where the money had come from and to show them a letter confirming that fact, but they would have none of it and proceeded to invade his home and his privacy. Eventually the police realized their error and left his home.

Although the police now admit that they investigated Mr. Syvertsen prior to the warrant being issued and found that he had never been implicated in any criminal activity, they insist that “there were reasonable grounds to suspect” criminal activity given the “sum of the information available,” that is,  the large cash payment. As Mr. Syvertsen points out, however, had the police waited until Monday, the matter could have been resolved “in a single phone call to the bank.” But the police are unrepentant and have the unmitigated gall to lecture law abiding citizens against carrying large sums of cash on their persons for their own safety–against private thugs, not police thugs of course. According to acting station commander Jarle Kolstad:

It is far safer to pay such large amounts [with] cards than to go with 80,000 [kroner] in cash on the body. Not because you risk getting the police at the door [really?], but because it is safer to use the cards. . . .

Mr Syvertsen’s reply to such self-serving nonsense?

It’s not stamped on my forehead that I have 80,000 [kroner] on the inside pocket, so I judge [it] as quite safe. Besides, I have previously experienced not [being able to] pay because payment terminals are down. Therefore, I chose to pay with cash, and there is no prohibition [against it] in Norwegian law. . . .

In the aftermath of this egregious home invasion, Mr. Syvertsen is suing the police for compensation. In the meantime, his experience with such lawless and arbitrary police conduct makes him feel unsafe in his own home and leaves him wondering “How low the threshold is supposed to be for police to intrude into private homes”? Well Mr. Syvertsen,as in the case of any government war against its own people (e.g., the War on Drugs, the War on Terror etc.) the threshold is very low indeed.

The political class via governments are trying to push all transactions into the banking system for them to control, regulate and easily seize them when expedient. That’s how seemingly desperate governments are today

US Stocks Hit Record Highs as the US Dollar Dives

Ben Bernanke’s Midas Touch via record stock market highs

From the International Business Times: (bold mine)

U.S. stocks shot into record territory Thursday after the head of the U.S. central bank hinted that its current unprecedented quantitative easing policy will not end any time soon.

On Wednesday, Federal Reserve Chairman Ben Bernanke, speaking after the bank's key interest-rate setting panel issued a nondefinitive statement of its intentions, said that the current employment level is overstating the health of the job market.

That comment suggested the central bank would keep buying large amounts of bonds, a policy it has been pursuing to suppress long-term interest rates. That policy also has helped lift U.S. equities.

Bad news is good news. Each account of bad news extrapolates to the prospects of more financial market bailout via the Bernanke Put. And Wall Street loves this transfer or implicit subsidy at the expense of the economy. [This isn't isolated to the US but applies everywhere]

Here is what I wrote last Sunday

Yet a stock market boom can be engineered by governments that could destroy historical precedents. Venezuela should be an example. Venezuela’s stock market has been up a stratospheric 160% year to date. This translates to star bound 460% in one and a half years. But Venezuela’s deceiving outperformance comes at a heavy toll: the collapse of her currency the Bolivar which means rising stocks are symptoms of hyperinflation.

Well record US stock market highs came in the backdrop a huge dive in the US dollar.

More signs of financial market engineering.

Seth Klarman: For if you must rescue everything, then ultimately you will be able to rescue nothing

It is simply breathtaking to see how financial markets have been hostaged by, or have become almost entirely dependent, on central bank utterances and actions. Markets experiences adrenaline rush or convulses depending on whether central bankers signal continuity of inflationism or not. Such volatilities are signs of the massive distortions and mispricing of the risk environment.

The legendary value investor and billionaire Seth Klarman has an apropos take on the sustainability of the de facto stimulus driven marketplace and economy. (As quoted by Zero Hedge; bold and italics original)

Is it possible that the average citizen understands our country's fiscal situation better than many of our politicians or prominent economists?

Most people seem to viscerally recognize that the absence of an immediate crisis does not mean we will not eventually face one. They are wary of believing promises by those who failed to predict previous crises in housing and in highly leveraged financial institutions.

They regard with skepticism those who don't accept that we have a debt problem, or insist that inflation will remain under control. (Indeed, they know inflation is not well under control, for they know how far the purchasing power of a dollar has dropped when they go to the supermarket or service station.)

They are pretty sure they are not getting reasonable value from the taxes they pay.

When an economist tells them that growing the nation's debt over the past 12 years from $6 trillion to $16 trillion is not a problem, and that doubling it again will still not be a problem, this simply does not compute. They know the trajectory we are on.

When politicians claim that this tax increase or that spending cut will generate trillions over the next decade, they are properly skeptical over whether anyone can truly know what will happen next year, let alone a decade or more from now.

They are wary of grand bargains that kick in years down the road, knowing that the failure to make hard decisions is how we got into today's mess. They remember that one of the basic principles of economics is scarcity, which is a powerful force in their own lives.

They know that a society's wealth is not unlimited, and that if the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse. For if you must rescue everything, then ultimately you will be able to rescue nothing.

They also know that the only reason paper money, backed not by anything tangible but only a promise, has any value at all is because it is scarce. With all the printing, the credibility of our entire trust-based monetary system will be increasingly called into question.

And when you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed's balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else--even, or perhaps especially, the  policymakers—does either.